Chapter 4 EconomicsforInvestment

Faculty of Investment
Economics for
investment decision
makers
Lecturer: Assoc.Prof. Pham Van Hung
www.khoadautu.neu.edu.vn
Chapter 4:
BUSINESS CYCLES AND
INVESTMENT
ACTIVITIES
Main contents
• Describe the business cycle and its phases
• Describe the typical theories of the business cycle
• Business cycle and investment policies
• Business cycle in VietNam

• Disscussion
What is business cycle ?
Business cycles ?
• Business cycles are the
type of fluctuation in
the aggregate economic
activity of nation that
organize their work
mainly in business
enterprises.
Business cycles
• Business cycles are • Such phases occur at
typical of economies about the same time
that rely mainly on throughout the
business enterprise economy (not just in
(not for centrally one industy)
planned economies) • Cycles are recurrent
• A cycle has an expected (happen again and
sequence of phases of again over time).
representing • Cycles typically last
alternation between between one and 12
expansion and years.
contraction
Phases of the business cycle
• A business cycle consists of 4 phases: expansion,
peak, contraction and trough.
• The period of expansion occurs after the trough
(lowest point) and before its peak (highest point).
Contraction is the period after the peak and before
the trough.
• During the expansion phase, aggregate economic
activity is increasing.
• During the contraction (recession), aggregate
economic activity is declining.
Business cycle
When Do Recesssions Begin ?
When do recession begin and end ?
• A recession has started when a country or region
experiences two consecutive quarters of negative
real GDP growth. Real GDP growth is measure of
inflation-adjusted growth of the overall economy.
• Some characteristics:
• consumer and business spending decreasing
• Demand for labour go down
• inflation accelerate
• Company's profit decelerate
• Stock market's index go down
When Do Expansions Begin and End?
When do Expansion begins?
• Real GDP, industrial poduction and other measures
of economic activity turn from decline to expansion
• Characteristics:
• Consumer and business spending increase
• Demand for labour go up
• Inflation remains modrates and may continue to fall
• Stock market's index increase
How do resoureces use in the
business cycle ?
Resource Use through the business
cycle
• When a downturn starts, Aggregate demand (AD)
decreases, shifting the AD curce left, inventories
start to accumulates. As a consequences,
companies may slow down production, thus idling
workers and physical capital, which futher
decreases AD and shifts the AD further to the left.
• In total, the equilibrium has move to lower prices
and lower GDP.
Impacts of recession on company's
investment ?
Impacts of recession on company's
investment ?
• Even though companies may not fire workers rights
away, they will likely reduce production, stop
ordering new inventories and new production
equipment. If enough companies act similarly, the
slow patch in business will be axacerbated.
• By the same token, if workers start worrrying that
lean years are coming, they may start saving more
so they have more reserves. Theses actions will also
reduce AD and futher, slow down the economy.
During a recession, what do investors
do in the financial market ?
During a recession, what do investors
do in the financial market ?
• During a recession, investors place relatively high
values on such safer assets as goverment securities
and shares of companies with steady positive cash
flows.
• Such preferences reflect the fact that the marginal
value of the safe income stream increases in the
periods when employment is insecure or going
down.
How do resources use in the
expansion ?
Theories of the business cycle
+ Neoclassical school:
+ Keynesian school:
+ Monetarist school:
+ The New classical school:
+ Real Business cycle Theory
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Neoclassical school
• Neoclassical school relied on the concept of general
equilibrium. All markets will reach equilibrium
because of the “invisible hand”.
• All resources are used efficiently based on the
priciple of marginal cost equaling marginal revenue,
no involuntary unemployment or capital take place.
• All that is produced will be sold because supply
creates its own demand.
• In Neoclassical, massive crisis, such as Great
Depression is impossible.
Keynesian school
• Generalized price and wage reduction, to bring
market back to equilibrium during recession, would
hard to obtain.
• When crises occur, the goverment should intervene
to keep capital and labour emplayed by deliberately
running a larger fiscal deficit. This intervention
would limit the damages of major recessions.
Monetarist school
• Monetatists advocate a focus on maintaining
steady growth of the money suply, and otherwise a
very limited role for government in the economy.
• According to the monetarists school, business cycle
may occur both because of exogenous shocks and
because of government intervention. It is better to
let AD and AS find their own equilibrium than to
risk causing futher economics fluctuation.
• A key part of monetarist thought is that the money
supply needs to continue to grow at the moderate
rate.
The new classical school
• Individual maximizing utility on the basic of rational
expectations and companies maximizing profits.
• New classical models are dynamic in the sense of
describing fluctuations over many periods and
present general equilibrium in the sense of
determining all prices rather than one price
• If all agents act in the similar fashion, the markets
will gradually adjust toward equilibrium.
Real Business cycle theory:
(Finn E.Kydland và Edward C. Prescott
- 2004)
• Expansion and contraction represent efficient
operation of the economy in respones to exteral
shocks. Because the level of economic activity at
any time is consistent with maximizing expected
utility, the policy recommendation of RBC theory is
for goverment not to intervene in the economy
with discretionary fiscal and monetary policy.
• RBC relies on efficient markets
Lessons to be learned by business
cycle (impact to investment activities)
?
Lessons
• Business cycle is not good and is not bad. Business
cycle are fundamental feature of market economy,
but the amptitude and length vary considerably.
• In macroeconomics, governement can have right
policy for better economic activities and then for
sustainable development.
• In microeconomic aspect, investors should learn
theories and understand the basic rules of business
cycle for rasonable investment decisons.
Business cycle in Viet Nam ?
Topic for group presentation
1, Business cycle in Việt nam ? What are the impacts
of business cycle on investment in Viet Nam ?
2, Application of fisal policy to control the business
cycle in VietNam ? Impact of fiscal policy on
investment activities in Viet Nam ?
3, Application of monetary policy to control the
business cycle in VietNam ? Impact of monetary
policy on investment activities in Viet Nam ?
Topic for group presentation
4, Why potential growth matters to investors ?
Analyze the case of VietNam ?
5, What are factors limiting growth in developing
countries ? Analyze the case of VietNam ?
6, Important of demand and supply analysis to
investment decision ? Give an example.
Practice problems
• 1, Which of the following rules is the most
commonly used to determine when recessions start
? Recession start when:
• A, The central bank runs out of foreign reserves
• B, Real GDP has two consecutive quarters of negative
growth
• C, economic activity experiences a material decline in
two buniness sectors
Practice problems
• 2, Suppose you are interested in forecasting
earnings growth for a company active in a country
where no official business cycle dating committee
exists. Which variables would you consider in
estimating peaks and troughs of that countries's
business cycle ?
• A, Inflation, the central bank's discount rate,
unemployment
• B, DJIA, equity market book value, monetary base
• C, GDP growth, unemployment, inflation, indutrial
production
Pratice problems
• 3, Though a small part of the overall economy,
inventories can reflect growth significantly because
they:
• A, reflect general business sentiment
• B, tend to move forcefully up or down
• C, determine the avalability of goods for sale
Pratice problems
• 4, Inventories tend to rise when:
• A, invetory-to-sales ratios are low
• B, inventory-to-sales ratio are high
• C, economic activity begins to rebound
• 5, Inventories will often fall early in a recovery
because:
• A,businesses need profit
• B, sales outstrip production
• C, businesses ramp up production because of increase
economic activity
Pratice problems
• 6, Durable goods have the most pronouned cyclical
behavior because:
• A, they have longer useful life
• B, their purchase can not be delayed
• C, they are needed more than nondurable goods or
service
7, Permanent income provides a better guide to:
• A, saving rate
• B, spending on services
• C, spending on durable goods
Pratice problems
• 8, Basic RBC model focus on the choices of a typical
individual, who can choose between consuming
more (thus giving up leisure) and enjoying leisure
more (thus giving up consumption). What causes
persistent unemployment in this model:
• A, contractionary monetary policy cause a shock to real
variable
• B, The economy returns to equilibrium promptly
• C, The utility function: individuals who prefer leisure
much more than consumption will forgo consumption
and instead choose unemployment to enjoy more
leisure when the market salary is low
Pratice problems
• 9, Productivity offers perspective on the business
cycle by
• A, showing the need for new employees
• B, assessing the skill set of existing employees
• C, measuring the intensity of work flow for existing
employees

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Faculty of Investment

• Business cycle and investment policies

• Business cycle in VietNam

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